The U.S. Treasury sells two types of savings bonds: Series EE and Series I. These bonds build value over time thanks to compound interest. Savings bonds mature in 20 years but continue to shell out interest for 10 years after that. Each savings bond series uses a different method to calculate interest, so each requires a different computation to figure its future value.
The United States government backs savings bonds with its full faith and credit. The bonds are safe, but returns are low. In August 2013, Series EE bonds paid 0.2 percent interest annually, and Series I paid 1.18 percent annually. Savings bonds offer several tax benefits. They are free of state and local taxes. You can postpone paying taxes on your interest income until you cash in your bonds. You might not have to pay tax on the bond interest if you use the bonds to pay for qualified education expenses.
Series EE Bonds
Series EE Bonds earn a fixed interest rate that's calculated monthly and that compounds semi-annually. This means that twice a year, the Treasury adds the previous six months' interest to the bond's principal, so that you begin to earn interest on that interest, The Treasury sets a new fixed rate on Series EE bonds twice a year, on May 1 and November 1. You earn interest from the first day of the month you buy the bonds. Computing the future value is a simple exercise in compounding interest. You can enter the necessary data into a calculator or spreadsheet to figure the answer quickly. The data you need are the purchase price of the bonds, the annual interest rate, the number of years until the bond matures and the number of times per year that interest compounds. The Treasury offers an online growth calculator that figures future value of Series EE bonds -- it even accounts for the effect of federal taxes on your net proceeds.
Series EE Example
The formula for the future value of a bond with a semi-annual compounding is as follows: future value equals current value multiplied by (((1 + (annual interest rate / 2) raised to the number of compounding periods in the future. For example, if you purchase an EE bond for $1,000 that pays 0.2 percent annually, compounded semi-annually, the future value in five years, or 10 compounding periods, is $1,000 x ((1 + (0.002 / 2)) raised to the power of 10), or $1,010.05. That's a long time to wait for $10.05 in income.
Series I Bonds
Series I bonds pay a composite interest rate containing fixed and variable portions. The Treasury announces the new semi-annual variable rate twice a year. The variable rate reflects the change in the Consumer Price Index, an indicator of inflation. The composite interest rate equals the fixed rate plus twice the six-month inflation rate plus the product of the fixed rate times the inflation rate. For example, the Series I bonds issued between May 1, 2013 and October 31, 2013 had a 0-percent fixed rate and used an inflation rate of 0.59 percent. Plugging these terms into the composite formula gives you a 1.18 percent annual rate.
The variable rate of Series I bonds makes it impossible to precisely compute its future value. You can set up a spreadsheet program containing your inflation forecasts for each six-month period from now through a future date, but your result is only as good as your forecasts. You can use the Treasury’s online growth calculator if you want an estimate of future value based on a single interest rate. The calculator allows you to incorporate additional periodic investments into your computation.
Based in Greenville SC, Eric Bank has been writing business-related articles since 1985. He holds an M.B.A. from New York University and an M.S. in finance from DePaul University. You can see samples of his work at ericbank.com.